Chapter 9 Bankruptcy – Municipalities

Table of Contents

Overview

Chapter 9 bankruptcy is a lesser known bankruptcy option that applies specifically to counties and municipalities. This also may include:

Tax Districts, such as Hospital Taxing Authorities

Municipal Utilities

School Districts

Chapter 9 bankruptcy works with municipalities and counties to reorganize debt. It offers a number of helpful debt management options, such as extending the repayment timeline, refinance of debt or for reduction of principal or interest on existing debts. Unlike what happens in a Chapter 7 bankruptcy case, the assets of a municipality are not liquidated under Chapter 9 bankruptcy filings. Instead, the Chapter 9 option provides financially distressed municipalities with protection from creditors by creating a plan between the municipality and its creditors to resolve the outstanding debt. Liquidation cannot be forced in the Chapter 9 process because municipalities and counties follow state law, whereas US bankruptcy courts are governed by Federal law.

So what exactly are the eligibility requirements for Chapter 9 filings? In order to qualify for Chapter 9, municipality entities must:

be specifically authorized to file for Chapter 9 under their respective state law

show that it is insolvent and cannot catch up with its debts otherwise

show willingness to cooperate with a plan to adjust its debts

have agreement from the majority of certain types of creditors or have evidence that an attempt to negotiate in good faith was made or that it would be impractical to negotiate or obtain an agreement with creditors

The decision to file Chapter 9 is not made quickly. This is due toone of the requirements including making an effort to negotiate with creditors prior to filing Chapter 9. A county or municipality entity may spend anywhere between a few months to multiple years in negotiation efforts. Once Chapter 9 is filed, an automated stay is enacted for the debtor that restricts all collections activities.

Chapter 9 filings are not common, but can carry very large debts. Since 1937, there have been a total of 680 Chapter 9 filings in the US. There have been 311 Chapter 9 filings in the US since 1980, and of those, 181 have been municipal utilities and special districts, and 54 have been primary governments: cities, counties, towns and villages. The remainder have included:

61Hospitals / Healthcare Systems

8Transportation Authorities

7Schools / Educational Organizations

Chapter 9 bankruptcies are not always effective: less than 70% of the Chapter 9 filings result in a confirmed plan of debt adjustment. Examples of Chapter 9 filings in the US include a 1994 filing by Orange County, California, in the amount of $1.2 billion. In 2013, Detroit made history with their Chapter 9 filing, carrying an estimated $18.5 billion debt, making it the largest municipal debt to ever be considered by the courts.

The Steps of a Chapter 9 Filing

Chapter 9 bankruptcy follows 5 specific steps:

Step 1The entity must prove itself to be a municipality within the definition of the Bankruptcy Code. The law states that a municipality “is specifically authorized, in its capacity as a municipality or by name, to be a debtor under such chapter by State law, or by a governmental officer or organization empowered by State law to authorize such entity to be a debtor under such chapter.” To be an eligible filer, the unit must be insolvent.

Step 2The filing entity is required to serve notice regarding the petition. The law requires weekly publication for three consecutive weeks in a general circulation newspaper. The court may also mandate that documents be mailed to certain creditors directly, and / or that additional media outlets be used for the announcement. This provides notice to concerned parties regarding the petition for relief and affected parties are given the chance to object.

Step 3The list of creditors is provided to the court. Laws state that this list must comprise the 20 largest creditors. The list is normally submitted with the petition under Chapter 9, but the bankruptcy court may choose to set a different timeline. The list of creditors may change as the situation evolves. The filing entity may also list claims that are in dispute or that are contingent. The debtor must show that it is trying to negotiate with creditors. In the event there are no sustainable objections to the petition, the court may order relief and an automatic stay to stop all collection actions and prohibit creditors from bringing a mandamus action against the debtor.

Step 4A plan of adjustment and a disclosure statement is filed with the court. This step may be redundant if the filing entity filed the plan of adjustment with the petition in Step 1, otherwise, the filing of the plan of adjustment may occur at any time after the petition is filed or as specified by the court. The plan may be modified at any time, but must be careful that the conditions of Chapter 9 are followed. The disclosure statement defines the operation of the plan after its confirmation.

Step 5In Step 5 planned adjustments are confirmed. US bankruptcy law lists seven discharge conditions, which include that the plan complies with Chapter 9, that the amounts paid under the plan are fully disclosed and reasonable, that any regulatory or electoral approval be obtained, and that the plan is feasible and in the best interests of the creditors. The court will set up a strict timetable for scheduling and deadlines before and during the hearings. In the event of confirmation, the court enters an order setting the plan in action, and all affected parties are notified.

All Chapter 9 filings are public record, just like other bankruptcy filing options.

Conclusion

While Chapter 9 is a rare bankruptcy filing option that does not follow all Federal laws, it is one that has been around for almost 100 years, and one that has been utilized by public municipality entities that need debt relief. Since counties, municipalities, healthcare systems, and school systems face the challenges of providing public services and need to accommodate the changing needs of their communities, it happens that they incur amounts of debt that can end up paralyzing part of their key operations. The Chapter 9 option can help them work out of that debt in an organized and transparent way.